South Africa’s central bank would do well to resist political pressure to cut rates.

For 30 years populist politicians have sought to pressure South Africa’s central bank into ill-advised rates cuts. The latest effort to do so takes the form of an attempt to broaden the bank’s mandate to include a focus on job creation. The inference is that South Africa’s interest rates sufficiently deter investment to explain the country’s very high rate of unemployment.

This is false. Borrowing costs are seldom cited anecdotally or in surveys as obstacles to investment or job creation. What does get cited are overall tax rates, taxes on capital invested, property rights uncertainty, skills levels, public infrastructure, and corruption. If politicians were serious about job creation this is where they would focus their efforts. 

Take overall tax rates as an example. Government revenue measured as a share of GDP is a good ten percentage points above the level it should be meaning that state extraction from the economy has exceeded a point of diminishing returns. South Africa is unique amongst emerging markets in taxing investor capital on arrival in the economy making all but the most lucrative and high-return investment projects not viable – thereby explaining why the country’s fixed investment rate is half of that of its emerging market peers. An expropriation law recently put into operation allows the seizure of any fixed or movable assets for less than market value.

And whilst spending an amount equivalent to its emerging market peers on education South Africa’s kids languish near the bottom of global rankings in maths and English proficiency. Moves towards putting rail and port infrastructure under private management remain too slow to extract the full export advantages that would arise from running South Africa’s export infrastructure at near 100% of its capacity.

Fix those things and the investment rate will lift sufficiently to see the economic growth rate approach that of South Africa’s emerging market peers. Cut interest rates faster to the same effect? At this newspaper we don’t think so.

But the even more important reason to take the pressure off the central bank is to prevent a social and political catastrophe. To shore up its currency South Africa needs to maintain a large interest differential between its rates and those in developed economies. The reason is to justify the taking funds out of a relatively low risk market such as the US and placing them in a relatively high-risk market such as South Africa. Reduce the rate differential and you reduce the justification for such investments.

For much of the past decade developed economy rates languished at near 0% and South Africa recorded at rate differential of near six percentage points with the US for example. But as US rates have lifted that differential has been halved.

Fortuitously as this occurred the US dollar, that was trading at extreme highs when Mr Trump came to power, has surrendered around 10% of its value creating the impression of some Rand resilience. Had it not been for the dollar weakening, and all other things being equal, the Rand would be trading at 19.65 to the dollar this morning and not 17.58.

If South Africa’s central bank cuts local rates to any significant extent the effect will be to reduce the differential further reducing what justification remains for taking funds out of a currency such as the US dollar and placing them in the Rand. That would lead to Rand weakening that might easily be accelerated by unanticipated political shocks. As the currency weakens the cost of imported goods increases. This drives inflation upwards. Rising inflation wrecks living standards and is a necessary condition therefore for social and political instability. That is perhaps what the populist critics of the central bank have always wanted. To date the government has been wise not to succumb to the pressure.